Two decades ago, the RBI recognised the necessity of managing risks and issued guidelines for establishing risk management departments (RMDs). Risk management practices are integral to banks today. Specialised staff identify, quantify risks and suggest risk mitigation plans.

Climate change has brought a new category of risk that banks need to reckon with. Risks to assets, population and economy are real. Identification and quantification of risks posed by climate change at borrowers’ and bankers’ level is complex. Protocols have to be established to assess and measure risks, increase capacities of borrowers and bankers, ensure their adaption and eventually integrate climate risks into the overall risk framework.

In comparison, standalone RMDs’ tasks are simple and yet took time to establish. Risks posed by climate change are non-linear, not backward looking and difficult to model/predict. Bankers must, therefore, prepare for the long haul, by nudging staff to develop competencies.

The RBI is a member of Basel Committee on bank supervision and adapted its principles of climate-related financial risks. It presented a discussion paper on climate risks in July 2022, made three announcements in its February 2023 MPC statement and issued draft disclosure guidelines on climate related financial risks in February 2024.

The guidelines mandate disclosures on governance, strategy, risk management, metrics and targets, and a glide path to enable banks and borrowers address climate related risks and transition to low carbon economy. Establishment of a robust ESG framework in financial sector entities and synchronised reportage at country level is the ultimate objective.

Banks have to apply a climate lens to their credit appraisal and risk management systems, measure risks and incorporate them in loan pricing. But its operational path is intricate.

As a bank, initial work relates to identifying differences between: (a) ground level climate resilience (green initiatives) that need financing; and (b) bank level climate risks to its assets and its operations. RBI guidelines primarily focus on banks’ recognition of their climate risks (especially disclosures), leaving green financing aspects to ‘governance and strategy’ of banks. Banks should focus on measurement and disclosures as also on financing green activities. It is in this context, a ‘To-Do’ list is proposed.

Set up an internal team to strategise and operationalise RBI’s draft disclosure guidelines. Bottom-up thinking and learning-by-doing builds ownership.

Banks should categorise their existing loan assets as ‘green’ (positive effect on climate), ‘blue’ (no positive or negative effect) and ‘grey’ (negative effect). Banks must develop an internal working-framework, take help of experts, if need be, as official taxonomy is under development. Development of ‘simple and non-negotiable norms’ to qualify assets.

Colour classification of assets and measurement of risk gives a broad measure of climate risks. Exact measurement is not easy, but without measurement we cannot move ahead!

Enhance appraisal and risk rating process with climate related financial risks including credit decision parameters.

Develop and incorporate climate risk indicators in the enterprise risk framework. The indicators can be based on sensitivity to temperature/water/extreme weather/GHG emission/etc.

Transforming climate science into climate economics is not straightforward. Assumptions that some assets are green could be fallacious. EVs are considered green. But what about thermal power which is charging EV batteries? Likewise, new-age fuel hydrogen has three shades [green, blue and grey].

Everyone is trying to learn and measure climate change related financial risks. It is good to hone the skills and knowledge internally.

Suryakumar is former Deputy Managing Director, NABARD. Srinivasan is a development consultant. Views are personal

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